The Banker’s Bunker: Where Banks Save Their Money (Part 2)

“Put simply, BOLI is attractive to the banks because it can produce better returns that the banks couldn’t otherwise achieve.”
– Fool.com, “Bank Owned Life Insurance: A Little Known Way Banks Make Money”

In Part 1 of “The Banker’s Bunker,” we introduced the phenomenon of BOLI, or bank-owned life insurance that has become a significant Tier 1 asset for many U.S. banks. We looked at how these plans work, the favorable returns and tax treatment compared to other cash equivalents, and how life insurance fits into Tier 1 assets held by banks.

Today, we’ll examine the impressive growth of bank-owned life insurance, the pros and cons of BOLI, and answers to common questions. Then we’ll look at what we can learn from the BOLI trend can be applied to our personal economies.

The Rapid Rise of BOLI

Banks have had the ability to purchase life insurance since early 1980’s, according to BankDirector.com. From nothing to many billions, it has grown steadily, often with double-digit annual gains in volume of cash surrender value (CSV). By 2008, the research of Barry James Dyke revealed a surprising fact: “According to the FDIC, banks are the largest purchasers of cash value life insurance in the United States.”

Immediately before and after the subprime crisis, both the number of banks purchasing life insurance and the amount of life insurance held by these banks increased dramatically. According to official BOLI holdings reports, BankInsurance.com, and other sources that report numbers from FDIC filings, BOLI assets held by banks and thrifts totaled $65.8 billion by the end of 2004. Two years later, at the end of 2006, the number had skyrocketed to $103.90 billion. By the end of 2011,  BOLI assets had reached $143.67 billion. And in another five years, at the end of 2016, CSV of BOLI policies held by banks and savings associations reached a new high of $161.8 billion. (Assets represent both new policies and cash value growth of existing policies, subtract claims paid, and do not include the value of death benefits.)

Today, over 62% of banks hold BOLI assets, according to reports based on regulatory filings. And as you can see on the chart below from the most recent Equias Alliance / Michael White BOLI Holdings Report, over 74% of banks with assets exceeding $300 million report owning bank-owned life insurance:

Most of the largest financial institutions in the US have used BOLI for many years. In recent years, thousands of community banks and thrifts have also jumped on the BOLI bandwagon, often looking for ways to fund the ever-rising cost of employee benefits, such as healthcare costs.

Who are the top holders of BOLI? The list below shows the top 20 banks and savings institutions in the U.S., measured by volume of CSV reported at the end of 2015:

As detailed in last week’s article, banks hold an average of 13-19% of their Tier 1 assets in life insurance contracts, and up to 25% is within regulatory guidelines.

The Benefits of BOLI

Why are many of the largest banks putting billions into cash value life insurance? Writing for Fool.com, Matthew Frankel names what may be the main benefit, “BOLI… can produce better returns that the banks couldn’t otherwise achieve.” However, as with traditional whole life, bank-owned life insurance provides many benefits that add up to much more than an anticipated rate of return.

Some key advantages of BOLI include:

• Superior returns to other safe investments, cash equivalents, and typical bank products.
• Low risk and high liquidity qualifies as Tier 1 capital, which is both required and essential to a bank’s stability and ability to lend.
• Cash value grows tax-deferred, and is never taxed if held until death.
• BOLI diversifies the bank’s investment portfolio.
• BOLI cash values do not need to be marked down if interest rates rise.
• Some policies offer minimum guarantees for cash value performance.
• Gains can efficiently offset costs associated with employee benefits programs.
• Tax-free death benefits indemnify the bank in the case of loss of a key employee.
• “Split-dollar” policies can provide valuable protection benefits for an executive’s heirs.
• Employee benefits funded by BOLI (such as healthcare and retirement benefits) allow a bank to attract and retain quality employees.
• There are broad and well-defined guidelines for permissible usage.
• As single-premium “MEC” policies, the cash surrender value is high.
• Policies have no surrender charges (although there may be tax consequences if policies are surrendered prematurely).
• Cash values are backed by the highest rated insurance companies in the nation.

There are also some disadvantages to BOLI…

• Unlike most personal whole life insurance policies, BOLI policies are single premium policies and therefore MECs: Modified Endowment Contracts.
• MECs have less favorable taxation treatment than life insurance contracts that are not considered However, this type of policies allows for efficient cash value growth.
• Although policies can be sold anytime, much like cashing out an IRA early, selling a BOLI policy before the death of the insured makes the gains taxable plus incurs a 10% penalty on gains.
• Due to tax treatment, BOLI policies are considered to be long-term assets on a bank’s balance sheet.
• If the credit quality of an insurer should decrease over time, it could increase risk.
• There is no guarantee that the tax-free gains of BOLI policies held to maturity will never be successfully challenged. However, industry insiders believe that current policies would be grandfathered in if taxation changed.

BOLI is a topic that is virtually ignored by the financial press, but it is a sizeable trend that deserves to be understood.

BOLI Q & A:

Some additional “BOLI Trivia” we uncovered in our research includes answers to the following questions…

Q. What insurance carriers sell BOLI?

A. Major carriers such as MassMutual, Guardian, New York Life, John Hancock, MetLife, Ohio National, and Prudential.

Q. Do employees agree to the policies?

A. While not required in all states, it is seen as a good practice to inform employees and receive consent. There is no cost and, with larger groups, no medical underwriting required.

Q. Why is BOLI an efficient funding tool for employee benefits?

A. Policies have higher returns than typical cash equivalents, and favorable tax treatment means BOLI delivers even higher equivalent yields compared with taxable assets. Cash value growth is tax-deferred during the life of the policy, and upon mortality, death proceeds are received tax-free.

Q. What kind of publicly available individual life insurance policy is the most similar to a BOLI policy?

A. A single premium whole life policy is the most similar. Like most BOLI policies, it is a MEC, which isn’t for everybody. Unlike a BOLI policy, it can provide some meaningful long-term care benefits. Learn about the pros and cons of this type of policy here.

Q. Do the families receive any benefit upon a bank employee’s death?

A. Sometimes. According to the Executive Benefits Network, many banks share a portion of the ultimate death benefits as an additional benefit to employees’ beneficiaries through a split dollar agreement.

Q. Is Bank Owned Life Insurance liquid?

A. BOLI can be surrendered at any time for its cash surrender value. However, as that will triggers taxation and even fees, banks almost always use it as a long-term asset.

Q. Are BOLI policies all the same?

A. No, there are three main types. General Account policies provide guaranteed minimums and reliable returns. Separate accounts and Hybrid accounts include more investment choices including some market exposure (along with higher risk ratings).

Q. How large is the average BOLI policy?

A. According to a 2013 review of FDIC data, newly issued policies had an average premium of about $2 million per case.

What We Can Learn from Bank-Owned Life Insurance

A family is not a business, and certainly not a bank. But we always encourage people to think of their finances (or their family’s finances) as their “personal economy.” And whether you’re a large bank or a family of one or two, some financial advice never goes out of style.

What lessons can we learn from banks that we can apply to our own finances? Banks and other savings institutions who remain healthy put tried-and-true financial advice to work:

• Think long-term, resisting short-term gains and speculation.
• Anticipate and prepare for costs, including unlikely losses.
• Save money in long-term assets with gains that outpace inflation.
• Build equity and ownership in “real” assets such as life insurance and real estate. (Consider how many buildings are named after banks, brokerages, and insurance companies.)
• Avoid speculation and short-term gains that come with high risk.
• Reduce or avoid taxation, remembering that what matters isn’t how much you earn, but how much you get to keep.
• Cash is King, or liquidity is essential!
• And don’t forget “rule #1” — Never lose money.

Financial Advice Worth Following

The trick to building wealth is to do what the financial institutions DO, not what they tell investors to do. While financial entertainers and mega-authors question and critique the value of high cash value permanent life insurance, our bedrock financial institutions contradict their advice through investing hundreds of billions of dollars in this same industry. This is a fact worth noting.

The subprime crisis revealed short-term thinking that generates short-term profits was proven to fail. Now with the rise of bank-owned life insurance, the jury is in: Life insurance can strengthen a bank corporation’s balance sheet, bringing stability, protection, long-term gains and favorable taxation.

What can you do to make your own personal economy more profitable in good times, more stable in the face of financial storms, and more flexible to face everyday challenges and opportunities? If you have been prejudiced against life insurance by those who misinform, we urge you to seek the facts. High cash value life insurance is “the banker’s secret” that can help you and your family prepare for a prosperous future.

Is it time to prepare for your future with tried-and-true financial solutions? We help clients create sustainable wealth that won’t vanish in a market or economic downturn. If you desire to generate greater cash flow from existing assets, utilize alternative investments to generate non-correlated growth, or use the protections, liquidity, and tax advantages of life insurance to build an effective financial foundation, we’re here to help.

And to find out more about our philosophy of Prosperity Economics, sign up for our complimentary Prosperity Accelerator Pack and receive a copy of Kim Butler’s ebook, Financial Planning Has Failed.